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Structured settlements allow injured parties settling lawsuits to receive tax-free income over a period of years and, often, for their entire lives. The Periodic Payment Settlement Act of 1982 solidified this arrangement as an option that provides financial stability to people who have suffered harm.

The Periodic Payment Settlement Act allowed injured parties to conclude litigation in a way that provided them with an ongoing stream of income to support their needs.

Before the late 1960s, structured settlements didn’t exist in the United States. Then some enterprising insurance executives came up with the idea of paying personal injury and other lawsuit settlements over time. Participants theorized that since traditional lump-sum court settlements were exempt from taxation, these new structured settlements should be tax exempt as well.

The Internal Revenue Service agreed, issuing a decision in 1979 to that effect. And ultimately, Congress got onboard. In 1982 lawmakers passed the Periodic Payment Settlement Act, which gave the settlements the full federal stamp of approval. The Act, which was the brainchild of Sen. Max Baucus, D-Montana, was signed into law in 1983 by President Ronald Reagan, a Republican.

Incremental Payments Ensure Long-Term Security

Unlike lump-sum court settlements, which are given to the injured party all at once or in a small number of payments, structured settlements involve a series of payments that form a stream of reliable income over a number of years.

When he introduced the Periodic Payment Settlement Act, Baucus explained that using a lump-sum settlement had “proven unsatisfactory…in many cases because it assumes that injured parties will wisely manage large sums of money so as to provide for their lifetime needs.”

What actually happened many times, Baucus said, was that injured people, especially minors, spent their lump-sum awards in just a few years and were left with no way to fund their needs.

Structured settlements, Baucus said, give injured people “a steady income over a long period of time and insulate them from pressures to squander their awards.”

According to the National Structured Settlements Trade Association, the Periodic Payment Settlement Act had bipartisan support in Congress. Lawmakers agreed with Baucus that structured settlements are a way to protect injured people from spending lump-sum legal settlements and being left with no means of support for the rest of their lives.

The NTSSA says that structured settlements also help parties save money by encouraging faster and more efficient conclusions to lawsuits.

Tax Exemptions for Periodic Payments

By bestowing tax advantages on the settlement recipient, as well as the parties making the payments, Congress encourages structured settlements as a means of restoring financial well-being to people who have been harmed and helping them avoid the need for public assistance. The law encourages the use of annuities to fund structured settlements.

At the same time as the Periodic Payment Settlement Act was approved, Congress also passed Internal Revenue Code Section 130, which governs the tax-free treatment of most structured settlements that receive funding through annuities or Treasury securities.

Pro Tip

The Internal Revenue Code requires structured settlements to be paid through a qualified funding asset, which includes “any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State, or any obligation of the United States.

Under the law, structured settlements are exempt from taxes in all cases involving injuries, sickness and wrongful death. One major advantage is that the total amount of the settlement fund can grow with no taxes and then be distributed to the settlement holder, who also pays no taxes.

With a lump-sum payment, the person who receives the funds may invest them, but they will owe taxes on any growth in those investments.

The law not only exempts injured parties from having to pay income taxes on structured settlements over many years, but it also makes it easier for the losing parties in the settlements to conclude their obligation to the plaintiffs at once. They may do this by issuing “qualified assignments,” or paying third-party structured settlement companies to administer the settlements.

The special treatment applies only to cases involving injury, sickness and death, however. In 1995, the U.S. Supreme Court ruled that the tax code provision didn’t apply to cases involving employment age discrimination when the claim didn’t involve sickness or injury.

Then in 1997, Congress extended the protections of the Periodic Payment Settlement Act to workers’ compensation cases involving employees injured on the job. President Bill Clinton signed that legislation, the Taxpayer Relief Act.

Structured Settlement Protection Acts

While structured settlements have been beneficial to thousands of injured people, they have one downside. By not allowing owners access to the bulk of their settlement funds, they do not allow for sometimes-needed infusions of cash.

So if someone with a structured settlement experienced a sudden need for a large sum of money, he or she would not be able to tap into the money in the settlement fund to withdraw more than the scheduled payments.

In response to this, factoring companies purchase the rights to future payments at a discount. This arrangement gives structured settlement holders a way to obtain large lump sums when they are needed.

Seeking to regulate these transactions and prevent injured people from being taken advantage of, the federal government imposed rules regulating these purchases. In short, the law imposes a 40 percent tax on these payment purchases unless they are made in accordance with state laws known as Structured Settlement Protection Acts.

The state laws require that any factoring transaction be approved by a judge, who must conclude that it is in the best interests of the settlement holder.